In a
note, RBS Analyst Chaytor focuses the sovereign CDS market and
whether investors should be freaked out about rising spreads.

RBS: Always a dangerous question to answer so early in January,
but the early signs are that sovereign risks are key. It is with
extreme interest that I note that the iTraxx Western European
Sovereign index is trading wide of both iTraxx Main and iTraxx
Senior Financials. Ignoring the potential internal consistency in
this (especially the latter) for another day it tells us that we
(the market) have some real concerns about quite a lot of the
sovereigns out there. This presumably stems from the difficult
deficit positions that many countries have necessarily found
themselves in following the measures taken to stem 2008's
economic catastrophe.

So, how worried should we be about this? At this stage, not a lot
I think. The sovereign CDS market is a useful addition to the
markets toolkit but it remains a small and illiquid market in
relation to the key one - the bond market. CDS vigilantes are a
growing and important force, but are as nothing compared to the
potential return of the bond vigilantes. What we have to be
focused on is whether these latter return. Not just because of
the obvious impact it would have on government bond markets but
the impact on all other markets. Whether you believe the risk
rally is built on excessive liquidity or on the market pricing a
return to decent growth rates, a higher cost of money would act
to kill that off very swiftly.

So, the Q1 key theme is, I think, whether moves in the sovereign
CDS world start to manifest themselves in the broader bond
markets. We have seen this already in Greece, but it's whether it
hits the big economies such as the US, UK, Japan or Germany that
is crucial. My central scenario is that it will not. That is why
I am happy to be tactically long 10y Treasuries through this
week's supply as I said yesterday, a trade which is working and I
would stick to. But let us keep a very close eye on key levels in
government bond markets over the next few months; as if yields
start to rise they could go a very, very long way. Being nimble
is vital; luckily the government bond market is liquid enough to
allow that.